While working as an equities trader at the Royal Bank of Canada, Brad Katsuyama noticed that when he tried to buy stocks for his clients, the offers vanished from his computer screen before he could complete the transaction, as if someone was watching him. And the stock prices went up.
In his quest to find out why, Katsuyama, the subject of Michael Lewis’ best seller Flash Boys: A Wall Street Revolt, discovered that high-frequency traders using computer algorithms can take advantage of their speed and proximity to stock exchanges to front run his trades.
His concern that the market was ripping off investors compelled him to quit his high-paying job and start his own stock exchange, IEX. Despite strong opposition from incumbent exchanges—“Why Wall Street hates this man” read the headline on a USA Today article—IEX won approval from the Securities and Exchange Commission in June 2016.
On Tuesday, March 21, Katsuyama brought his “David among Goliaths” story to Lehigh, detailing his efforts to restore balance and trust to the market. His hour-long talk in Baker Hall, which included a question-and-answer segment, was presented by the Center for Financial Services at the College of Business and Economics, the Visiting Lecturers Committee and the Zoellner Arts Center.
I figured you out, Katsuyama said Lewis had told him one day after having delved into his background for the book. You were never looking for a fight. The fight found you, and you decided to fight back.
“I always made it a point to get along with people,” Katsuyama acknowledged. But at certain points in time, a person’s character is tested, he said. “You have to recognize these moments, when they’re happening, and you’ve got to dig deep to figure out what you’re about and make those decisions.
“I was never looking for this,” he said. “Frankly, it’s kind of an uncomfortable position to be hated.”
Katsuyama said he had an epiphany after discovering, with the help of technology experts, that the problem was not isolated to the Royal Bank of Canada but was a systemic market issue that was costing investors by the millisecond. “You know, we’re not the first people to discover anything,” he said he realized. “Maybe we’re 20th…Everyone who discovered what we discovered is part of the problem.”
The issue is not that high frequency trading is bad, he said, but that the system is broken. And what’s truly broken, he added, is that incumbent exchanges sell high-speed data and technology to participants that allow them to outrace others. They make more money at that, he said, than trading.
“Some say, that’s just progress,” he said, “except that exchanges are held to a higher standard.”
Katsuyama began to question the integrity of the U.S. stock market. “To say that millions and millions and millions of people are losing tens, hundreds, thousands of dollars, it’s diffuse harm. Everybody’s losing little bits, and it’s all funneling into the pockets of a very small number of people. It’s billions of dollars a year being scalped out of people’s retirements and pensions. I had a problem with that.”
He set out to solve the problem, not exploit it. His group’s free market solution was to start IEX.
“We wanted to be about protecting investors,” he said.
If other exchanges were deriving their business model by selling speed, he said, IEX would counter by slowing people down and neutralizing the speed edge. Katsuyama’s group developed what has been called a “speed bump,” a 38-mile coil of fiber optic cable that slows trading by 350 microseconds. The point of doing that, he said, is make sure high-speed traders cannot trade on IEX with advanced information and cannot use information on IEX to trade on other markets.
“By fixing the loophole...you’re not exploiting it,” he said. “If you’re not exploiting it, you’re preventing scandals. And if you’re preventing scandals, you’re preventing the next set of rules that will prevent the next disruptor or the next innovator from entering your market.”
On the first day of trading, IEX did 568,000 shares, he said. Its record day is 440 million shares.
“We stood for what we believed in,” he said. “At the end of the day, the public, investors, the people we were trying to protect stood up and fought.”
Katsuyama said he learned a great lesson through the process—to surround oneself with people who are different. He said technologists taught him more about how the stock market actually worked than the traders who had trained him on the trading desk, even though they didn’t even understand the value of their knowledge base.
Life has a lot to do with luck, Katsuyama said.
“I just found my circumstance,” he said, “and I made a series of choices.”